Chapter 2: Broadcast rights – IAS 2 or IAS 38

Broadcasters purchase programs under a variety of different arrangements. Often, they commit to purchasing programs that are at a very early stage of development, perhaps merely being concepts. The broadcaster may have exclusive rights over the program or perhaps only have the rights to broadcast for a set period or on a set number of occasions.

IFRS is not clear on how these rights should be classified and when they should be recognized. We believe that an entity may either treat these rights as intangible assets and classify them under IAS 38 – Intangible Assets, or classify them as inventory under IAS 2. Such rights would certainly seem to meet the definition of inventory under IAS 2.

Given that the acquisition of these rights forms part of the cost of the broadcaster’s programming schedule, they meet the general IAS 2 definition in that they are:

(a) held for sale in the ordinary course of business;

(b) in the process of production for such sale; or

(c) in the form of materials or supplies to be consumed in the production process or the rendering of services.

When classified as inventory, the rights will need to be disclosed within current assets, even if the intention is not to consume them within 12 months.

As with costs of other inventory the cash outflow from acquisition will be classified as an operating cash flow and the expense will be presented within the cost of sales when the right is consumed. There is also the issue of the timing of recognition of these rights. Under The Conceptual Framework for Financial Reporting (2010), an asset is a resource controlled by an entity as a result of past events and from which future economic benefits are expected to flow to the entity.

In March 2018, the IASB issued a revised Conceptual Framework for Financial Reporting. The revised framework became effective immediately for the IASB and IFRS Interpretations Committee and is effective from 1 January 2020 for entities that use the Conceptual Framework to develop accounting policies when no IFRS standard applies to a particular transaction.

The revised Conceptual Framework defines an asset as a present economic resource controlled by the entity as a result of past events. Hence it is necessary to determine when control is obtained. Under IFRS, executory contracts where both parties are still to perform (such as purchase orders where neither payment nor delivery has taken place) do not generally result in the recognition of assets and liabilities.

When a broadcaster initially contracts to purchase a program, it will not usually result in immediate recognition of an asset relating to that program. At this point, there will not normally be an asset under the control of the broadcaster. Factors that may be relevant in determining when the entity controls an asset include whether:

• the underlying resource is sufficiently developed to be identifiable (e.g., whether the manuscript or screenplay has been written, and whether directors and actors have been hired);
• the entity has legal, exclusive rights to broadcast, which may be in respect of a defined period or geographic area;
• there is a penalty to the licensor for non-delivery of the content;
• content will probably be delivered; and
• economic benefits will probably flow to the entity.

Where there is difficulty in determining when control of the asset is obtained it may be helpful to assess at what point any liability arises, since a liability will generally indicate that an asset has been acquired.

In practice, an entity might recognize an asset and liability for a specific broadcast right on the following trigger dates:

• when a screening certificate is obtained;
• when programming is available for exhibition;
• the beginning of the season;
• the beginning of the license period; or
• the date the event occurs (e.g., game-by-game basis).

Emission rights – IAS 2 or IAS 38 In order to encourage entities to reduce emissions of pollutants, governments around the world have introduced schemes that comprise tradeable emissions allowances or permits. Entities using emission rights for their own purposes may elect to record the rights as intangible assets, whether at cost, revalued amount or, under the so-called ‘net liability’ approach, as rights that are re-measured to fair value. It may also be appropriate to recognise emission rights, whether granted by the government or purchased by an entity, as inventory in accordance with IAS 2 if they are held for sale in the ordinary course of business or to settle an emissions liability in the ordinary course of business. If the purchased emission rights are recognised as inventories, they are subsequently measured at the lower of cost or net realisable value in accordance with IAS 2, unless they are held by commodity broker-traders. Broker-traders account for emission rights as inventory. A broker-trader may recognise emission rights either at the lower of cost and net realisable value, or at fair value less costs to sell as permitted by IAS 2. An integrated entity may hold emission rights both for own-use and for trading. An entity accounts for these emission rights separately.

Transfers of rental assets to inventory An entity may, in the course of its ordinary activities, routinely sell items that had previously been held for rental and classified as property, plant and equipment. For example, car rental companies may acquire vehicles with the intention of holding them as rental cars for a limited period and then selling them. IAS 16 requires that when such items become held for sale rather than rental, they be transferred to inventory at their carrying value. Revenue from the subsequent sale is then recognised gross rather than net.

Consignment stock and sale and repurchase agreements A seller may enter into an arrangement with a distributor where the distributor sells inventory on behalf of the seller. Such consignment arrangements are common in certain industries, such as the automotive industry. Under IFRS 15, revenue would generally not be recognised for stock delivered to the consignee because control has not yet transferred, and the seller would continue to account for the consignment inventory until control has passed. Similarly, entities may enter into sale and repurchase agreements with a customer where the seller agrees to repurchase inventory under particular circumstances. For example, the seller may agree to repurchase any inventory that the customer has not sold to a third party after six months. IFRS 15 contains complex guidance, which can result in the entity accounting for such arrangements as financing arrangements, as leases, or as a sale with a right of return. Where an arrangement is accounted for as a financing arrangement, the seller will continue to recognise the inventory on its balance sheet and will also recognise a financial liability for the consideration received. If IFRS 15 requires the arrangement to be accounted for as a lease, the arrangement must be accounted for in accordance with IFRS 16 – Leases (or IAS 17 – Leases – if that standard is still applied). If the seller is considered to be acting as lessor in a finance lease, the inventory subject to the arrangement would be derecognised and the seller would instead recognise a finance lease receivable. If the seller is considered to be acting as lessor in an operating lease, the seller would continue to recognise the inventory on balance sheet. For arrangements that are considered to be a sale with a right of return, inventory will be derecognised and the seller will instead recognise a right of return asset. The entity will also have to consider appropriate disclosure for material amounts of inventory that is held on consignment or sale and return at a third party’s premises.

Property demolition and operating lease costs

During a property redevelopment project, an existing building may need to be demolished for the new development to take place.

Should the cost of the building to be demolished be capitalized as part of the construction cost for the new building or should the cost be charged to profit or loss?

In all such cases, an entity will need to exercise judgment in assessing the facts and circumstances. There are three distinct scenarios to consider:

(a) the entity is the owner-occupier, in which case the matter falls under IAS 16;

(b) the entity holds the property to earn rentals, in which case the matter falls under IAS 40;

(c) the entity sells such properties in its normal course of business.

IAS 2 defines inventories as assets:

(a) held for sale in the ordinary course of business; or

(b) in the process of production for such sale; or

(c) in the form of materials or supplies to be consumed in the production process or the rendering of services.

The cost of inventories must comprise all costs of purchase, costs of conversion, and other costs incurred in bringing the inventories to their present location and condition.

If it is the strategy of the developer to sell the developed property after construction, the new development falls within the scope of IAS 2, as it would be considered held for sale in the normal course of business by the developer.

The cost of the old building as well as demolition costs and costs of developing the new one would be treated as inventory but must still be subject to the normal ‘lower of cost and net realisable value’ requirements.

In our view, a similar approach can be applied to lease costs for the land upon which a building is being constructed. For entities still applying IAS 17 the amount that can be included in inventory will depend on whether the entity considers the land lease to be a finance lease or an operating lease.

• If it is a finance lease, depreciation is an example of a fixed cost that can be considered a cost of conversion. IAS 2 states that, in limited circumstances, borrowing costs are to be included in the costs of inventories.

It is quite possible that buildings constructed for disposal on land held under a finance lease could meet these criteria.

• If the entity considers it to be an operating lease, the operating lease costs could be considered costs of conversion.

Alternatively, the entity could consider that the operating lease costs are for the right to control the land during the lease period rather than costs in bringing this inventory to any particular condition, in which case it may be appropriate to expense the costs.

Sales with a right of return An entity may provide its customers with a right to return goods that it has sold to them. The right may be contractual, or an implicit right that exists due to the entity’s customary business practice, or a combination of both. Offering a right of return in a sales agreement obliges the selling entity to stand ready to accept any returned product. Under IFRS 15, the potential for customer returns needs to be considered when an entity estimates the transaction price because potential returns are a component of variable consideration. IFRS 15 also requires that the selling entity recognise the amount received or receivable that is expected to be returned to the customer as a refund liability and recognise a return asset for its right to recover goods returned by the customer. The carrying value of the return asset is presented separately from inventory.

What may be included in the cost?

The costs attributed to inventories under IAS 2 comprise all costs of purchase, costs of conversion, and other costs incurred in bringing the inventories to their present location and condition.

This definition allows for significant interpretation of the costs to be included in inventory.

Costs of purchase

Costs of purchase include import duties and unrecoverable taxes, transport, handling, and other costs directly attributable to the inventories. Trade discounts and similar rebates should be deducted from the costs attributed to inventories. For example, a supplier may pay its customer an upfront cash incentive when entering into a contract. This is a form of rebate and the incentive should be accounted for as a liability by the customer until it receives the related inventory, which is then shown at cost net of this incentive.

Other costs Other costs are to be included in inventories only to the extent that they bring them into their present location and condition. Often judgement will be necessary to make this assessment. An example is given in IAS 2 of design costs for a special order for a particular customer and the standard notes that it may be appropriate to include such costs or other non-production overheads. However, a number of examples are given of costs that are specifically disallowed. These are: (a) abnormal amounts of wasted materials, labour, or other production costs; (b) storage costs, unless those costs are necessary in the production process prior to a further production stage; (c) administrative overheads that do not contribute to bringing inventories to their present location and condition; and (d) selling costs.

Storage and distribution costs

Storage costs are not permitted as part of the cost of inventory unless they are necessary in the production process.

This appears to prohibit including the costs of the warehouse and the overheads of a retail outlet as part of the inventory, as neither of these is a prelude to a further production stage. Where it is necessary to store raw materials or work in progress before a further processing or manufacturing stage, the costs of such storage should be included in production overheads.

For example, it would appear reasonable to allow the costs of storing maturing stocks, such as cheese, wine, or whisky, in the cost of production. Although distribution costs are the cost of bringing an item to its present location, the question arises as to whether the costs of transporting inventory from one location to another are eligible.

Costs of distribution to the customer are not allowed as they are selling costs, which are prohibited by the standard from being included in the carrying value of inventory.

It therefore seems probable that distribution costs of inventory whose production process is complete should not normally be included in its carrying value. If the inventory is transferred from one of the entity’s storage facilities to another and the condition of the inventory is not changed at either location, none of the warehousing costs may be included in inventory costs. It follows that transportation costs between the two storage facilities should not be included in the carrying value of inventory.

A question arises about the meaning of ‘production’ in the context of large retailers with distribution centers, for example, supermarkets. As the transport and logistics involved are essential to their ability to put goods on sale at a particular location in an appropriate condition, it seems reasonable to conclude that such costs are an essential part of the production process and can be included in the cost of inventory. The circumstances of the entity may warrant the inclusion of distribution or other costs into the cost of sales even though they have been excluded from the cost of inventory.

General and administrative overheads

IAS 2 specifically disallows administrative overheads that do not contribute to bringing inventories to their present location and condition. Other costs and overheads that do contribute are allowable as costs of production. There is a judgment to be made about such matters, as under a very broad interpretation any department could be considered to contribute.

For example, the accounts department will normally support the following functions:

(a) production – by paying direct and indirect production wages and salaries, by controlling purchases and related payments, and by preparing periodic financial statements for the production units;

(b) marketing and distribution – by analyzing sales and by controlling the sales ledger; and

(c) general administration – by preparing management accounts and annual financial statements and budgets, by controlling cash resources, and by planning investments.

Only those costs of the accounts department that can be allocated to the production function can be included in the cost of conversion. Part of the management and overhead costs of a large retailer’s logistical department may be included in the cost if it can be related to bringing the inventory to its present location and condition.

These types of costs are unlikely to be material in the context of the inventory total held by organizations. An entity wishing to include a material amount of overhead of a borderline nature must ensure it can sensibly justify its inclusion under the provisions of IAS 2 by presenting an analysis of the function and its contribution to the production process similar to the above.

Forward contracts to purchase inventory

The standard scopes out commodity broker-traders that measure inventory at fair value less costs to sell from its measurement requirements.

If a broker-trader had a forward contract for the purchase of inventory this contract would be accounted for as a derivative under IFRS 9 since it would not meet the normal purchase or sale exemption and when the contract was physically settled, the inventory would likewise be shown at fair value less costs to sell.

However, if such an entity were not measuring inventory at fair value fewer costs to sell it would be subject to the measurement requirements of IAS 2 and would therefore have to record the inventory at the lower of cost and net realizable value. This raises the question: what is the cost when such an entity takes delivery of inventory that has been purchased with a forward contract?

On delivery, the cash paid (i.e., the fixed price agreed in the forward contract) is in substance made up of two elements:

• an amount that settles the forward contract; and
• an amount that represents the ‘cost of purchase’, being the market price at the date of purchase.

This ‘cost of purchase’ represents the forward contract price adjusted for the derivative asset or liability. For example, assume that the broker-trader was purchasing oil and the forward contracted price was $40 per barrel of oil, but at the time of delivery the spot price of oil was $50 and the forward contract had a fair value of $10 at that date. The oil would be recorded at the fair value on what is deemed to be the purchase date of $50. The $40 cash payment would in substance consist of a $50 payment for the inventory offset by a $10 receipt on settlement of the derivative contract, which would be separately accounted for.

This is the same result as if the entity had been required to settle the derivative immediately before, and separate from, the physical delivery of the oil. If the entity purchasing the oil in the example above is not a broker-trader, and the acquisition meets the normal purchase or sale exemption given in IAS 32, the purchase of oil would be recognized at the entity’s cost thereof; in terms of IAS 2, that is $40 per barrel of oil.

Drug production costs within the pharmaceutical industry

After the development stage, pharmaceutical companies often commence production of drugs before obtaining the necessary regulatory approval to sell them. As long as the regulatory approval has been applied for and it is believed highly likely that this will be successfully obtained then it is appropriate to be recognising an asset and classifying this as inventory. Before this application for regulatory approval is made any costs would need to be classified as research and development costs rather than inventory and the criteria within IAS 38 were assessed to determine if capitalization was appropriate.